tag:theconversation.com,2011:/uk/topics/nobel-prize-for-economics-17295/articlesNobel Prize for Economics – The Conversation2020-10-12T23:20:48Ztag:theconversation.com,2011:article/1479812020-10-12T23:20:48Z2020-10-12T23:20:48ZMaking auctions work: the winning ideas behind this year’s Nobel Prize in economics<figure><img src="https://images.theconversation.com/files/363054/original/file-20201012-15-1i5twcf.jpg?ixlib=rb-1.1.0&rect=379%2C166%2C2336%2C1207&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Robert Wilson and Paul Milgrom, winners of The 2020 Nobel Prize in economics.</span> <span class="attribution"><span class="source">Andrew Brodhead/Stanford</span></span></figcaption></figure><p>More than ever before, auctions shape the economy.</p>
<p>Sites such as eBay have made them an everyday transaction. The placement of every Google ad is priced by an instantaneous mini-auction. Governments use them to allocate <a href="https://theconversation.com/wireless-spectrum-is-for-sale-but-what-is-it-11794">radio spectrum</a> and to run emissions trading schemes. </p>
<p>The 2020 Nobel Prize in economics has been awarded to two Americans, <a href="https://profiles.stanford.edu/paul-milgrom">Paul Milgrom</a> and <a href="https://www.gsb.stanford.edu/faculty-research/faculty/robert-wilson">Robert Wilson</a>, for their work in analysing auctions and how to make them more efficient. </p>
<p>The two professors are close collaborators. They both work at Stanford University in California and also live on the same street. </p>
<p>The economics prize is not one of the original categories endowed from Alfred Nobel’s will. Its formal name is the Sveriges Riksbank Prize in Economic Sciences in memory of Alfred Nobel. The winners are selected by the same Royal Swedish Academy of Sciences that awards the prizes for <a href="https://www.nobelprize.org/">physics and chemistry</a>.</p>
<p>Milgrom and Wilson work in various areas of economics (notably game theory) but are best known for their work in market design. Milgrom was awarded his PhD from Stanford in 1978, where he was one of Wilson’s students. </p>
<p>The American Economics Association has described Milgrom as the <a href="https://www.aeaweb.org/about-aea/honors-awards/distinguished-fellows/paul-milgrom">world’s leading auction designer</a>. His work has been cited more than <a href="https://scholar.google.com/citations?user=b4cFNacAAAAJ&hl=en&oi=ao">100,000 times</a>. </p>
<h2>The winner’s curse</h2>
<p>The Royal Swedish Academy of Sciences has emphasised that Milgrom and Wilson have won the award for both their theoretical work and its practical application in auctions. </p>
<p>This is not the first time the economic prize has gone to theory relevant to auctions. William Vickrey and James Mirrlees won in 1996 for their work on incentives. </p>
<p>The 2017 winner, behavioural economist Richard Thaler, has also brought attention to the phenomenon at the heart of the work for which Milgrom and Wilson have been awarded – known as “the winner’s curse”.</p>
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Read more:
<a href="https://theconversation.com/why-richard-thaler-won-the-2017-economics-nobel-prize-85404">Why Richard Thaler won the 2017 economics Nobel Prize</a>
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<p>The winner’s curse arises from people bidding for something whose value is unknown at the time but will be agreed later. Economists call this a “common value” auction. </p>
<p>An example might be the right to mine for gold in a certain location. If no gold is found, the right will turn out to be worthless. If there is a lot of gold, it will be valuable. </p>
<p>Different bidders may have different opinions about how much gold is in the site. The more optimistic they are, the more they will be willing to bid. The most optimistic bid will win. </p>
<p>But the true value is likely to turn out much closer to the average rather than the highest valuation. So winning bidders are likely to overpay. </p>
<h2>Common versus private values</h2>
<p>Wilson’s work has shown the fear of the winner’s curse leads rational bidders to bid less than their own valuation. </p>
<p>Greater uncertainty, or the belief some participants have more information than others, will make bidders even more cautious. Their final price will therefore be lower.</p>
<p>Milgrom built on this to examine the case of auctions where there is not only a common value but also a private value that differs between bidders. </p>
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Read more:
<a href="https://theconversation.com/match-making-economists-earn-nobel-prize-for-economic-engineering-10147">Match-making economists earn Nobel prize for economic engineering</a>
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<p>An example would be a house. A quiet, safe and convenient location is likely to be a common value. But features such as a pool or a large garden might be valued very differently, as some buyers see them only as a chore. </p>
<p>This will give rise to different private values.</p>
<h2>The design of the auction matters</h2>
<p>The most common type of auction is an “English auction”, where the auctioneer starts with a low price and it is bid up until only one bidder is left. </p>
<p>There are also “Dutch auctions”, where the auctioneer starts with a high price and lowers it until someone buys. </p>
<p>Economists had assumed the format of the auction would make no difference to the outcome. But Milgrom showed the problem of the winner’s curse is greater in the Dutch auction, because bidders do not learn anything from watching other bidders drop out. </p>
<p>The final price is therefore likely to be lower in a Dutch auction.</p>
<h2>More than merely academic</h2>
<p>How have such insights helped society? </p>
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<a href="https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/363056/original/file-20201012-17-1bglahg.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Simultaneous auctions make more money.</span>
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<p>For one thing, Milgrom and Wilson developed a complex form of auction – the “simultaneous multiple round auction”. This allows bidding for more than one thing at the same time and allows repeated bids. </p>
<p>It is useful, for example, if a company wants to bid for a licence in one area only if it can also have the licence in another area.</p>
<p>If the auctions were held sequentially, the uncertainty about winning the second auction would depress bids in the first auction.</p>
<p>Running auctions simultaneously allows governments to maximise the price <a href="https://www.nobelprize.org/prizes/economic-sciences/2020/popular-information/">for valuable assets such as radio spectrum rights</a>.</p>
<p>This gives governments more money to spend on public services such as health and education. </p>
<p>Economists are often derided as “academic scribblers”. This year’s Nobel economics prize is a clear example of economists having practical outcomes in the public interest.</p><img src="https://counter.theconversation.com/content/147981/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Hawkins does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>For their work on auctions and ‘the winner’s curse’, Stanford neigbhours Paul Milgrom and Robert Wilson have won the 2020 Nobel Prize for economics.John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of CanberraLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1283982019-12-09T08:19:24Z2019-12-09T08:19:24ZHow randomised trials became big in development economics<figure><img src="https://images.theconversation.com/files/305633/original/file-20191206-90574-s3efbs.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Esther Duflo (L) and Abhijit Banerjee, who, along with Michael Kremer (not pictured), won the 2019 Nobel Prize in Economic Sciences.</span> <span class="attribution"><span class="source">EPA/CJ Gunther</span></span></figcaption></figure><p>The 2019 Nobel Prize in economics was awarded to three researchers <a href="https://www.nobelprize.org/prizes/economic-sciences/2019/advanced-information/">for</a> “their experimental approach to alleviating global poverty”, one which has “transformed development economics”. </p>
<p>What are randomised experiments? And why have they became so influential in development economics? </p>
<p>Improving the quality of life, particularly for the poor, is considered to be one of the main objectives of modern societies. Doing so requires a certain level of wealth. Economists have been preoccupied for centuries with understanding why some nations have “developed” economically and others have not. </p>
<p>But a more immediate question is: what can be done in the present? More specifically, what policies should less-developed countries adopt to improve the lives of their citizens?</p>
<p>Development economics as a subdiscipline was born in the 1940s and 1950s. For pioneers such as <a href="https://www.iss.nl/en/about-iss/organization/honorary-fellows/paul-rosenstein-rodan">Paul Rosenstein-Rodan</a>,<a href="https://www.nobelprize.org/prizes/economic-sciences/1979/lewis/biographical/"> W. Arthur Lewis</a> and <a href="https://en.wikipedia.org/wiki/Albert_O._Hirschman">Albert Hirschman</a>, development economics meant studying ways in which poor countries could attain large-scale societal transformation. They used a variety of analytical approaches, which pointed towards industrialisation as the driver of development.</p>
<p>Arthur Lewis, a native of Saint Lucia, was awarded the <a href="https://www.nobelprize.org/prizes/economic-sciences/1979/lewis/facts/">1979 Nobel Prize</a> in economics. This was in recognition of his study of the ways in which countries with unlimited supplies of labour – as is the case for many developing countries – could attain economic development.</p>
<p>One view of the challenge of development is that it is fundamentally about answering causal questions. If a country adopts a particular policy, will that cause an increase in economic growth, a reduction in poverty or some other improvement in the well-being of citizens?</p>
<p>In recent decades economists have been concerned about the reliability of <a href="https://www.degruyter.com/view/j/jgd.2015.6.issue-1/jgd-2014-0005/jgd-2014-0005.xml">previously used methods</a> for identifying causal relationships. In addition to those methodological concerns, some have argued that “grand theories of development” are either incorrect or at least have failed to yield meaningful improvements in many developing countries. </p>
<p>Two notable examples are the idea that developing countries may be caught in a poverty trap that requires a “<a href="https://link.springer.com/article/10.1007/s10887-006-9006-7">big push</a>” to escape and the view that <a href="https://link.springer.com/chapter/10.1007/978-3-540-69305-5_25">institutions</a> are key for growth and development.</p>
<p>These concerns about methods and policies provided a fertile ground for randomised experiments in development economics. The surge of interest in experimental approaches in economics began in the early 1990s. Researchers began to use “natural experiments”, where for example random variation was <a href="https://www.jstor.org/stable/2006669">part of a policy</a> rather than decided by a researcher, to look at causation. </p>
<p>But it really gathered momentum in the 2000s, with researchers such as the Nobel awardees designing and implementing experiments to study a wide range of microeconomic questions. </p>
<h2>Randomised trials</h2>
<p>Proponents of these methods <a href="https://economics.mit.edu/faculty/eduflo/pooreconomics">argued</a> that a focus on “small” problems was more likely to succeed. They also argued that randomised experiments would <a href="https://www.aeaweb.org/articles?id=10.1257/jep.24.2.3">bring credibility</a> to economic analysis by providing a simple solution to causal questions.</p>
<p>These experiments randomly allocate a treatment to some members of a group and compare the outcomes against the other members who did not receive treatment. For example, to test whether providing credit helps to grow small firms or increase their likelihood of success, a researcher might partner with a financial institution and randomly allocate credit to applicants that meet certain basic requirements. Then a year later the researcher would compare changes in sales or employment in small firms that received the credit to those that did not. </p>
<p>Randomised trials are not a new research method. They are best known for their use in testing new medicines. The first medical experiment to use controlled randomisation <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3149409/">occurred</a> in the aftermath of the second world war. The British government used it to assess the effectiveness of a drug for <a href="https://doi.org/10.1258/jrsm.2011.11k023">tuberculosis treatment</a>. </p>
<p>In the <a href="https://journals.sagepub.com/doi/pdf/10.1177/0011128700046003004?casa_token=XbxU7ET54eIAAAAA:RorDHa1w1n7bdaUVD79pX7jsrB6Tflu-Q94FXQVaAK7Sb59ChXQ9C2dhxIPq4Z1Tj-y6sXp7paEpmA">early 20th century</a> and <a href="https://journals.sagepub.com/doi/10.1177/0193841X7800200411">mid-20th century</a> American researchers had used experiments like this to examine the effects of various social policies. Examples included income protection and social housing.</p>
<p>The introduction of these methods into development economics also followed an increase in their use in <a href="https://www.aeaweb.org/articles?id=10.1257/jep.24.2.3">other areas of economics</a>. One example was the study of labour markets. </p>
<p>Randomised control trials in economics are now mostly used to evaluate the impact of social policy interventions in poor and middle-income countries. Work by the 2019 Nobel awardees – Michael Kremer, Abhijit Banerjee and Esther Duflo – includes experiments in Kenya and India on <a href="https://www.aeaweb.org/articles?id=10.1257/aer.102.4.1241">teacher attendance</a>, <a href="https://www.aeaweb.org/articles?id=10.1257/app.1.1.112">textbook provision</a>, <a href="https://academic.oup.com/jeea/article-abstract/6/2-3/487/2295851">monitoring of nurse attendance</a> and the <a href="https://www.aeaweb.org/articles?id=10.1257/app.20140287">provision of microcredit</a>.</p>
<p>The popularity, among academics and policymakers, of the approach is not only due to its seeming ability to solve methodological and policy concerns. It is also due to very deliberate, well-funded advocacy by its proponents.</p>
<h2>Big funders</h2>
<p>A key actor is the Abdul Latif Jameel Poverty Action Lab (J-PAL), which was founded by Duflo and Banerjee. Since its creation in 2003, J-PAL <a href="https://www.jstor.org/stable/pdf/26491530.pdf">has conducted</a> 876 policy experiments in 80 countries. <a href="https://www.amazon.fr/L%C3%A9conomie-comportementale-question-Jean-Michel-Servet/dp/2843772087">One estimate</a> suggests that it received around $300 million between 2003 and 2018, from a range of institutions. These include the World Bank, Britain’s Department for International Development and the Bill and Melinda Gates Foundation.</p>
<p>J-PAL appears to <a href="https://doi.org/10.1111/dech.12378">have been influential</a> in the World Bank’s decision in 2005 to establish a dedicated impact evaluation unit composed of former J-PAL associates to conduct randomised trials. The number of such experiments used in World Bank evaluations <a href="https://doi.org/10.1111/dech.12378">increased</a> from zero in 2000 to just over two thirds of all evaluations in 2010.</p>
<p>These changes have taken place in a broader international context where there is increased emphasis on “<a href="https://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/3683.pdf">evidence-based policy</a>”. The idea is that policy decisions should be based on “objective”, “rigorous” and “rational” information and analysis. Although this may seem obvious, there are many debates about what this actually means in practice.</p>
<p>In this context, the advocates of randomised trials have sought to position their preferred methods as the most reliable form of evidence.</p>
<p>But there is strong opposition to the approach. This <a href="https://www.sciencedirect.com/science/article/pii/S0277953617307359">argues that</a> experiments are not as reliable or useful as they are made out to be. Some even say that many such experiments <a href="https://ore.exeter.ac.uk/repository/bitstream/handle/10871/17048/EthicsRCT.pdf">fail to satisfy ethical principles</a> and may actually <a href="https://africasacountry.com/2019/10/the-poverty-of-poor-economics">harm</a> development efforts.</p>
<p><em>This is the first article in a two-part series on randomised trials. The next will argue that the usefulness and appropriateness of randomised trials for development questions has been severely overstated.</em></p><img src="https://counter.theconversation.com/content/128398/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Seán Mfundza Muller receives funding from a European Union-funded project, "Putting People back in Parliament", led by the Dullah Omar Institute (University of the Western Cape), in collaboration with the Parliamentary Monitoring Group, Public Service Accountability Monitor (Rhodes) and Heinrich Boell Foundation (South Africa). He is affiliated with the Public and Environmental Economics Research Centre (University of Johannesburg), regularly making inputs to Parliament oversight of the national budget, advising civil society groups on public finance matters and consulting for private sector organisations on an ad hoc basis. He resigned from the South African Parliamentary Budget Office in 2016. The views expressed are his own.</span></em></p><p class="fine-print"><em><span>Grieve Chelwa has received funding from the DG Murray Trust for work on the economics of alcohol consumption in South Africa. He has also received funding from the Bill and Melinda Gates Foundation, the American Cancer Society and the International Development Research Center 9IDRC) for work on the economics of tobacco control on the African continent. And lastly, he's received funding from the International Growth Center at LSE and the Volkswagen Foundation for his work on the economics of education in Zambia. </span></em></p><p class="fine-print"><em><span>Nimi Hoffmann has received funding from the South African Department of Basic Education to help conduct a nationally representative survey of teachers. She has also received funding from the European Commission to conduct a tracer study of schools for children displaced by conflict and climate collapse in Somalia and Ethiopia. She is a lecturer at the Centre for International Education at the University of Sussex and a research fellow at the Centre for International Education, Cape Peninsula University of Technology.</span></em></p>The surge of interest in experimental approaches in economics began in the early 1990s.Seán Mfundza Muller, Senior Lecturer in Economics, Research Associate at the Public and Environmental Economics Research Centre (PEERC) and Visiting Fellow at the Johannesburg Institute of Advanced Study (JIAS), University of JohannesburgGrieve Chelwa, Senior Lecturer -- Economics, University of Cape TownNimi Hoffmann, Lecturer in International Education, University of SussexLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1252762019-10-14T16:41:33Z2019-10-14T16:41:33ZEconomics Nobel 2019: why Banerjee, Duflo and Kremer won<p>The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2019 (commonly known as the Nobel Prize for Economics) <a href="https://twitter.com/NobelPrize/status/1183681045591445504?s=20">has been awarded</a> to Abhijit Banerjee, Esther Duflo and Michael Kremer “for their experimental approach to alleviating global poverty”. Through the award, the Nobel committee recognised both the significance of development economics in the world today and the innovative approaches developed by these three economists.</p>
<p>Global poverty continues to be a massive challenge. The award follows Angus Deaton, <a href="https://theconversation.com/correct-and-brilliant-angus-deatons-work-is-a-model-of-applied-economics-49033">who received it in 2015</a> for his contributions to development economics – the field that studies the causes of global poverty and how best to combat it – particularly, his emphasis on people’s consumption choices and the measurement of well-being, especially the well-being of the poor. </p>
<p>Well-developed theory can highlight what causes poverty and, based on this, suggest policies to combat it. But it cannot tell us exactly how powerful specific policy measures will be in practice. This is precisely where the contributions of Banerjee, Duflo and Kremer lie. The <a href="https://www.nobelprize.org/prizes/economic-sciences/2019/press-release/">Nobel citation</a> gives several examples of their impact, including how their research has helped education, health and access to credit for many in the developing world, most famously in India and Kenya. </p>
<p>Consider, for example, child mortality and health – issues of immense significance in the developing world. Theory can tell us that women’s empowerment is important for child health and mortality outcomes, but cannot tell us which policy will be most effective in combating this. It could be a focus on educating mothers, or access to healthcare, or electoral representation, or marital age legislation. </p>
<p>Perhaps, more importantly, theory cannot tell us how large and significant the impact will be of these various policies. And this is where the significance of the Nobel Prize this year comes in.</p>
<h2>A new, experimental approach</h2>
<p>The fundamental contribution of Banerjee, Duflo and Kremer was to develop an experimental approach to development economics. They built a scientific framework and used hard data to identify causes of poverty, estimate the effects of different policies and then evaluate their cost effectiveness. Specifically, they developed randomised control trials (RCTs) to do this. They used these to study different policies in action and to promote those that were most effective. </p>
<p>Starting in the mid-1990s, Kremer and co-authors started a series of RCTs on schooling in Kenya, designing field experiments to evaluate the impact of specific policies on improving outcomes. This approach was revolutionary. The experiments showed that neither more textbooks nor free school meals made any real difference to learning outcomes. Instead, it was the way that teaching was carried out that was the biggest factor.</p>
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<p>Studies by Banerjee and Duflo, often together with Kremer and others, followed. They initially focused on education, and then expanded into other areas, including health, credit and agriculture. </p>
<p>Banerjee and Duflo were able to use these studies to explain why some businesses and people in less developed countries do not take advantage of the best available technologies. They highlighted the significance of market imperfections and government failures. By devising policies to specifically address the root of problems, they have helped make possible real contributions to alleviating poverty in these countries. </p>
<p>Banerjee, Duflo and Kremer also took significant steps towards applying specific findings to different contexts. This brought economic theories of incentives closer to direct application, fundamentally transforming the practice of development economics, by using practical, verifiable and quantitative knowledge to isolate causes of poverty and to devise adequate policy based on behavioural responses. </p>
<p>The impact of these developments upon real world development outcomes are immensely significant. Their work, and substantial amounts of research that followed it, established evidence on fighting poverty in many developing countries. And they are continuously expanding their horizon of contributions, which now also includes climate and environmental policy, social networks and cognitive science.</p>
<h2>Diversity issues</h2>
<p>The 2019 Nobel Prize for Economics is also significant for reasons of inclusivity. The impact generated by Banerjee, Duflo and Kremer’s approach has come about very quickly - actually, in less than two decades. This explains why, at the age of 47, Duflo is the youngest-ever recipient of the economics Nobel. She is also only the second woman to be awarded the prize (after Elinor Ostrom in 2009). Banerjee, who is also her husband, is the third ever non-white recipient (after Arthur Lewis in 1979 and Amartya Sen in 1998). </p>
<p>In a <a href="https://www.nature.com/articles/d41586-019-02988-5">recent issue of the journal Nature</a>, Göran Hansson, head of the Royal Swedish Academy of Sciences that awards the Nobel, highlighted measures to address the imbalance in gender and ethnicity among winners. He said “we are making sure to elect women to the academy” from which the prize-awarding committees for the chemistry, physics and economics Nobels are drawn. </p>
<p>The pipeline to this achievement is important. The first woman to win the John Bates Clark Medal for top economists under 40, an important indicator of who will be awarded the economics Nobel in the future, Susan Athey, only did so in 2007. Esther Duflo was the second winner in 2010. Since then, women winners of the Clark medal have been more frequent. Of course, award decisions are made strictly on significance of contributions. But, based on this evidence, perhaps Athey, Amy Finkelstein (who won the medal in 2012) and Emi Nakamura (who won it in 2019) will not be far behind.</p><img src="https://counter.theconversation.com/content/125276/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Abhijit Banerjee, Esther Duflo and Michael Kremer win the Nobel Prize for Economics ‘for their experimental approach to alleviating global poverty’.Arnab Bhattacharjee, Professor of Economics, Heriot-Watt UniversityMark Schaffer, Professor of Economics, Heriot-Watt UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/854302017-10-09T18:52:43Z2017-10-09T18:52:43ZEconomist who helped behavioral ‘nudges’ go mainstream wins Nobel<figure><img src="https://images.theconversation.com/files/189440/original/file-20171009-6960-9uqy7s.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">As a founder of behavioral economics, Thaler has helped change the way economists look at the world.
</span> <span class="attribution"><span class="source">AP Photo/Paul Beaty</span></span></figcaption></figure><p>The <a href="http://www.kva.se/en/startsida">2017 Nobel Prize in economics</a> was awarded to University of Chicago’s <a href="http://faculty.chicagobooth.edu/Richard.Thaler/index.html">Richard Thaler</a> for his work in <a href="https://theconversation.com/us/topics/behavioral-economics-14384">behavioral economics</a>, which is the integration of economics with psychology. </p>
<p>While the award was not a total surprise, since Thaler’s name was floated earlier on the <a href="https://blogs.wsj.com/economics/2017/10/03/who-will-win-the-2017-nobel-prize-in-economics/">list of potential winners</a>, it highlights the growing importance of incorporating how humans actually behave into economic thinking. It marks the second time a pioneer in the burgeoning field of behavioral economics – which hardly existed a few decades ago – has won a Nobel, the first being psychologist <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2002/">Daniel Kahneman</a> in 2002. </p>
<p>It may be hard to believe, but before these scholars came along, many economists assumed that humans acted like <a href="http://www.startrek.com/database_article/spock">Spock</a> on “Star Trek.” People were supposed to be perfectly rational calculating machines that looked at all the information and made correct choices. However, even a most casual view of the real world suggests this is not a good assumption.</p>
<p>So who is Thaler and what’s so important about his work?</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=399&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=399&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=399&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=501&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=501&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189442/original/file-20171009-6984-1ymailk.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=501&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Before Thaler and his peers came along, economists assumed people behaved a lot like Spock.</span>
<span class="attribution"><span class="source">AP Photo/Bob Galbraith</span></span>
</figcaption>
</figure>
<h2>Thaler’s impact</h2>
<p><a href="http://faculty.chicagobooth.edu/Richard.Thaler/vitae/CV.pdf">Richard Thaler</a> was born in 1945 in East Orange, New Jersey. He studied at Case Western and the University of Rochester, where he earned a Ph.D. in economics in 1974. </p>
<p>His doctoral thesis offered one of the earliest <a href="https://books.google.com/books/about/The_Value_of_Saving_a_Life.html?id=luXjtwAACAAJ">estimates of the value of saving a life</a>, calculations that <a href="http://www.law.harvard.edu/programs/olin_center/papers/pdf/Viscusi_517.pdf">governments</a> and businesses use to determine how much they should spend to prevent fatalities. For example, when the government is considering new air quality regulations that will cost companies money, it compares the price tag against the value of lives saved if the changes are implemented. </p>
<p>Thaler estimated that a life saved was worth about <a href="http://www.nber.org/chapters/c3964.pdf">US$200,000</a> in 1967 dollars, or about <a href="https://www.bls.gov/data/inflation_calculator.htm">$1.5 million</a> in 2017 terms. Today, government agencies value a life <a href="http://www.nytimes.com/2011/02/17/business/economy/17regulation.html">five to six times higher</a> than that. </p>
<p>Thaler may be best-known for the bestselling book “<a href="https://yalebooks.yale.edu/book/9780300122237/nudge">Nudge</a>,” which he co-wrote with Harvard law professor Cass Sunstein. “Nudge” is credited with inspiring former Prime Minster David Cameron to create the U.K.’s <a href="http://www.behaviouralinsights.co.uk">Behavioral Insights Team</a>, which uses psychological principles to improve the effectiveness of public services. Former President Barack Obama <a href="https://theconversation.com/how-the-science-of-human-behavior-is-beginning-to-reshape-the-us-government-48145">set up a similar group</a> in the White House.</p>
<p>Thaler and Sunstein argue people should not be forced to do things with bans or laws. Instead, small interventions, or nudges, that make the right choice easier are the best way to go. They offer examples such as putting healthy food where people can see and reach it easily while relegating unhealthy options to out-of-the-way spots. Since people usually make the easy choice, moving food around will result in less junk food being eaten.</p>
<p>Another example is making automatic retirement contributions the <a href="https://theconversation.com/how-the-science-of-human-behavior-is-beginning-to-reshape-the-us-government-48145">default choice</a> when someone begins a new job. This means new employees will have to fill out paperwork to stop contributions instead of to start them. As a result, more people save for retirement.</p>
<p>More specifically, the Royal Swedish Academy of Sciences selected Thaler for his <a href="http://www.kva.se/en/pressroom/pressmeddelanden/ekonomipriset-2017">work in three areas</a>: “limited rationality,” “social preferences” and “lack of self-control.”</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=395&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=395&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=395&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=497&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=497&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189441/original/file-20171009-6973-acys7v.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=497&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Thaler and Sunstein showed how making healthier options more visible makes it more likely people will choose them.</span>
<span class="attribution"><span class="source">AP Photo/Hans Pennink</span></span>
</figcaption>
</figure>
<h2>Limits of our reason</h2>
<p>Thaler pointed out that because people often can’t solve many problems in their economic lives, they simplify and use rules of thumb. These simplifications, however, lead to strange and sometimes bad choices.</p>
<p><a href="http://www.washingtonpost.com/wp-dyn/content/article/2007/05/19/AR2007051900316.html">Mental accounting</a> is one area of strange choices that Thaler was the first to identify. Because our financial lives are complex, we mentally put money in separate buckets and spend only the money available in that bucket. </p>
<p>For example, <a href="http://www.economiapsicologica.com.br/wp-content/uploads/2009/05/thaler-mental-accounting-and-consumer-choice.pdf">Thaler describes a couple</a> who receives $300 in cash compensation from an airline for lost baggage. The couple takes the $300 and spends it on a fancy dinner. They splurged for the dinner only because, in their heads, they classified $300 as a windfall. But if their salaries had simply increased by a total of $300, they would likely not have splurged on eating out but instead mentally classified the extra money as spending for rent and other bills.</p>
<h2>Adding emotion to economics</h2>
<p>He also won the Nobel for his work on social preferences and fairness. </p>
<p><a href="http://www.jstor.org/stable/1806070">Thaler, with co-authors Kahneman and Canadian economist Jack Knetsch</a>, showed in 1986 how customers don’t expect companies to maximize profits in all situations. For example, when there’s a blizzard, people don’t expect stores to raise the price of shovels, even though demand will naturally soar as the snow piles up. Thaler and his co-authors showed that customers will tend to punish businesses that do. This is a surprising result since it shows that businesses that maximize <a href="http://businessmacroeconomics.com/">profits</a> in the short term, as many do, can be penalized in the long term if customers think the companies are acting unfairly.</p>
<p>This work has relevance today for understanding consumers’ reactions to drug companies pushing <a href="https://www.nytimes.com/2017/09/17/insider/insider-high-drug-prices-opioids.html">prescription drug prices ever higher</a> and to businesses <a href="http://www.businessinsider.com/price-gouging-in-texas-gas-prices-hurricane-2017-9">price-gouging</a> after hurricanes. Thaler points out <a href="http://www.jstor.org/stable/2647056">that emotions</a>, like feelings about fairness, are an important but overlooked area of economics.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=437&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=437&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=437&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=550&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=550&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189439/original/file-20171009-6990-13dgu9j.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=550&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Daniel Kahneman makes a toast with his wife Anne Treisman after winning the Nobel Prize in economics.</span>
<span class="attribution"><span class="source">AP Photo/Daniel Hulshizer</span></span>
</figcaption>
</figure>
<h2>Paying for self-control</h2>
<p>A third area cited by the Swedish Academy was the contribution Thaler and economist Hersh Shefrin made on ideas about <a href="https://www.jstor.org/stable/1806070?seq=1#page_scan_tab_contents">self-control</a>.</p>
<p>The economists noted that people spend money to avoid making poor choices or to avoid engaging in the wrong kinds of behaviors. For example, Thaler and Shefrin wrote that people “pay to go to ‘<a href="http://www.foxnews.com/travel/2013/04/22/americas-top-10-weight-loss-resorts.html">fat farms</a>’ which essentially are resorts that promise not to feed their customers.”</p>
<p>Individuals not only pay for self-control but also create special rules to ensure they don’t go beyond self-imposed limits. Smokers, for instance, often buy cigarettes by the pack instead of by the carton. This ensures they smoke less each day, even though they pay more per cigarette. </p>
<p>Thaler’s work on self-control is becoming more important as the internet and almost instant delivery make more of the <a href="https://www.amazon.com/Temptation-Finding-Self-Control-Age-Excess/dp/0143120808">world’s temptations easier to access</a> without waiting. Understanding how people actually operate results in better public policies that can achieve the same results without costing people money.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=388&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=388&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=388&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=487&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=487&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189443/original/file-20171009-6999-ui1k38.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=487&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Even though regular smokers would save money by buying cigarettes by the carton, many purchase one pack at a time as a means of self-control.</span>
<span class="attribution"><span class="source">AP Photo/Ed Wray</span></span>
</figcaption>
</figure>
<h2>It’s all about us</h2>
<p>The award is worth <a href="https://www.nobelprize.org/nobel_prizes/about/amounts/prize_amounts_17.pdf">9 million Swedish kronor</a>, which at today’s exchange rate is about $1.1 million. Unfortunately for Thaler, since he is an American, the <a href="https://taxfoundation.org/nobel-prize-award-subject-income-taxation/">entire award is taxable</a> income – unless it is donated to a charity.</p>
<p><a href="https://www.nytimes.com/2017/10/09/business/nobel-economics-richard-thaler.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=second-column-region&region=top-news&WT.nav=top-news">Asked how he would spend the money</a>, he said: “This is quite a funny question… I will try to spend it as irrationally as possible.”</p>
<p>The Nobel Memorial Prize in Economic Science, the only award not created by <a href="https://www.nobelprize.org/alfred_nobel/will/">Alfred Nobel in his will</a>, also brings enormous prestige to the winner. Economist Friedrich Hayek, who won the prize in 1974, <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1974/hayek-speech.html">said it confers</a> on an individual an “influence over laymen: politicians, journalists, civil servants and the public generally.”</p>
<p>Beyond this influence, why should you care? The <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/">list of past economics Nobel Prize winners</a> contains many people whose work is fascinating to economists but whose relevance to the lives of regular people is tenuous. </p>
<p>Richard Thaler’s work, however, has direct relevance for pretty much everyone. His early research helps save lives. His later research helps people save for retirement and helps save us from our own worst tendencies. The Swedish Academy made an astute choice in lauding his work.</p><img src="https://counter.theconversation.com/content/85430/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jay L. Zagorsky does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Richard Thaler won the 2017 Nobel Prize in economics for his groundbreaking work incorporating how humans actually behave into economic thinking.Jay L. Zagorsky, Economist and Research Scientist, The Ohio State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/854042017-10-09T13:11:05Z2017-10-09T13:11:05ZWhy Richard Thaler won the 2017 economics Nobel Prize<p>The 49th Sveriges Riksbank prize in economic sciences – commonly referred to as the Nobel Prize for economics – <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/">has been awarded to Richard H Thaler</a> for his contributions to behavioural economics. He was a key proponent of the idea that humans do not act entirely rationally. By applying insights from psychological research, he helped the world better understand people’s economic decision-making in particular.</p>
<p>Thaler published extensively in the field of finance. He pinpointed the difference between the predictions in financial literature, which assume that people act perfectly rationally to maximise their expected profits (the idea of the <a href="https://theconversation.com/danger-strikes-when-foolish-humans-are-left-in-charge-of-their-financial-futures-45262"><em>homo economicus</em></a>), and what actually happens on the markets. </p>
<p>Thaler was on many people’s list of Nobel favourites. But since the award already went to Daniel Kahneman in 2002 for behavioural economics and then jointly to <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2013/press.html">Eugene Fama, Lars Peter Hansen and Robert Shiller</a> in 2013 for financial markets, his chances seemed relatively slim. But the Great Recession – caused by financial markets seeming to behave “irrationally” – brought a lot of attention to research that extensively cites Thaler’s 40-year long academic career. He even made a guest appearance in the film The Big Short <a href="https://www.wired.com/2015/12/big-short-understanding-economics/">to explain</a> why banks kept buying and selling bad debt to their detriment.</p>
<p>People are not perfect computers, and Thaler’s research on limited rationality demonstrates this. For instance, people tend to be loss averse: they’d rather expect a smaller payoff with the same risk, but cap their losses. This obviously has implications for financial markets: financial products based on the binary options of profit or loss, for instance, rely heavily on advertising that any potential losses are limited. </p>
<h2>Mental accounting</h2>
<p>Another contribution of Thaler was the concept of <a href="http://www.economiapsicologica.com.br/wp-content/uploads/2009/05/thaler-mental-accounting-and-consumer-choice.pdf">mental accounting</a>: people don’t, it turns out, think about their total lifetime welfare when making financial decisions. Instead they focus on the performance of individual decisions and are less concerned with making savings if they are a small percentage of what’s being spent. This idea led to the development of the field of behavioural finance, which addresses the implications of limited rationality.</p>
<p>For instance, if you could save $1 on a burger by going elsewhere, you’d probably go for it. But if you could save the same amount of $1 on exchanging your currency for a holiday, you will not – even if the time you lose to go to another currency exchange is the same as the time you would lose to go to another burger joint. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/189418/original/file-20171009-6960-16gw0fw.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Burgernomics.</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>Related to this, Thaler has conducted a lot of research to show how bad humans are at <a href="http://faculty.chicagobooth.edu/richard.thaler/research/pdf/smartjpe.pdf">long-term financial planning</a>. Despite the fact that we now expect to live a long time; left to our own devices, most people will not plan sufficiently for retirement. The growing problem of obesity also shows how bad humans are at serving their best interests. </p>
<p>To understand this, Thaler proposed that it’s necessary to view each individual as two people: one side of you that plans, the other that does (or doesn’t do) what is planned. The planner side of you might see perfect sense in signing up for a yearly gym membership – it expects you to go to the gym everyday and get fit. But the doer side of you might not follow through with this; it makes perfect sense for the doer side of you to repeatedly postpone the gym trip to when it’s more convenient, until the year is up. </p>
<p>That’s how gyms make their money – by appealing to the planner side of your personality. We need to understand the planner and the doer side of our personalities in order to follow through with our intentions. Similarly, governments might be interested in regulating contracts that exploit this disconnect between people’s long-term interests and everyday decision making.</p>
<h2>Nudge theory</h2>
<p>These psychological insights also play an important role in nudge theory – another concept <a href="https://www.amazon.co.uk/Nudge-Improving-Decisions-Health-Happiness/dp/0141040017">developed by Thaler</a>. Nudging is where small stimuli are provided to influence people’s behaviour. Nudges work at an individual level, but they are also used by companies. </p>
<p>For example, Thaler showed how companies can use strategies to present buying options in the most favourable way to customers. Small nudges in the way that sales people operate or present their goods can influence people’s spending. For instance whether or not a company should offer a complete version of its software vs a cut-down version for free. Or when a car salesman gives you a discount: they will often quote a 20% higher price first and then lower it to frame the price as a personal discount just for you.</p>
<p>Nudge theory has also been adopted by governments to try and ensure their citizens are better prepared for the future. For example, by automatically enrolling people into pension schemes, making them opt-out instead of opt-in, has massively increased the number of people with plans, compared to if they had to actively elect into one. </p>
<p>I hope this Nobel prize award will attract the public’s attention and encourage many to acknowledge the irrationality of their decision making. As well as seeing the value in regulating financial markets so they are not susceptible to irrational behaviour, by acknowledging this tendency, we can make better plans for our futures – ones that our “doer” sides are happy to follow.</p><img src="https://counter.theconversation.com/content/85404/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sergey V. Popov does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>His work on behavioural economics helps us better understand why people make bad financial decisions.Sergey V. Popov, Lecturer in Economics, Cardiff UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/831712017-08-29T11:30:25Z2017-08-29T11:30:25ZHow inequality became the big issue troubling the world’s top economists<figure><img src="https://images.theconversation.com/files/183744/original/file-20170829-10454-jcn2n4.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Unbalanced.</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>Every three years, all Nobel Prize winners in economics are <a href="http://www.mediatheque.lindau-nobel.org/meetings/2017-eco">invited to gather</a> in the tranquil setting of the German island of Lindau to meet a selection of bright young economists and discuss the state of their profession. But this year such tranquility was challenged by worrying political developments across the globe. Perhaps unexpectedly, one of the central themes of the meeting became what to do about inequality. </p>
<p>While not all laureates would go as far as Jean Tirole, the 2014 Nobel Prize winner, who said that economic inequality itself is a form of <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2014/tirole-lecture.pdf">“market failure”</a>, it is clear that the political and social effects of growing inequality are drawing increasing attention from those at the top of the economics profession. </p>
<p>In a panel discussion on inequality, <a href="https://heckmanequation.org/about-professor-heckman/">James Heckman</a>, the 2000 Nobel laureate, pointed out that inequality had grown faster in the US and the UK than other Western democracies. Heckman said that changes to the tax system that favoured the rich had to be a key part of the explanation. He was also worried about the decline in social mobility, particularly for those on low pay. </p>
<p>Heckman also pointed out that the low income of many single-parent families, whose numbers have <a href="https://www.theatlantic.com/business/archive/2013/09/the-mysterious-and-alarming-rise-of-single-parenthood-in-america/279203/">increased</a> <a href="https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/families/bulletins/familiesandhouseholds/2015-01-28">sharply</a> over the last few decades, had also <a href="https://www.theguardian.com/australia-news/2017/aug/02/poverty-on-rise-in-single-parent-families-as-childcare-costs-bite">increased inequality</a>. He argued strongly for wage subsidies to boost the income of the working poor, and increased subsidies for childcare to help more single parents enter the labour market.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/183752/original/file-20170829-10454-1dz8nem.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">James Heckman in conversation with young economists at Lindau.</span>
<span class="attribution"><a class="source" href="http://www.mediatheque.lindau-nobel.org/pictures/37274/gallery-2017-eco#/1">Lindau Nobel Laureates Meetings</a></span>
</figcaption>
</figure>
<h2>Towards a Universal Basic Income</h2>
<p>Peter Diamond and Sir Christopher Pissarides, who shared the Nobel Prize in 2010 <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2010/press.html">for their work on labour markets</a>, both told me that they now favoured a <a href="https://theconversation.com/can-universal-basic-income-counter-the-ill-effects-of-the-gig-economy-75581">universal basic income</a> (UBI), which would give a minimum basic income to all citizens regardless of their economic status. Pissarides argued that the rapid spread of robots and AI is a threat to large numbers of less-skilled jobs. Without some government intervention, this will widen inequality, he believes. He would support UBI as long as it was carefully calibrated to be below the minimum wage to avoid disrupting the labour market. </p>
<p>Diamond told me that the growing inequality in the US was now as issue that had to be faced. In a <a href="http://onlinelibrary.wiley.com/doi/10.1111/coep.12184/full">recent paper</a>, he demonstrated just how much the US was an outlier across a wide range of measures of inequality, including income, wealth, poverty and social mobility.</p>
<p>Diamond believes that the debate on inequality can help focus discussion on policy failures: from the lack of investment in education, research and infrastructure, to the failure to compensate those who bore the cost of globalisation through job losses in heavy industry. He also argues that direct transfers, including introducing child benefit to everyone who has children and a UBI, would help tackle poverty. While he does not think that the goal of policy should necessarily be focused on redistributing wealth, he believes that the economic challenges in the US require a higher level of government spending, and therefore higher taxation on the better off. </p>
<p>Both Diamond and Pissarides are prepared to consider higher taxes on wealth as part of the policy mix. Focusing on the US, Diamond favours a substantial increase in inheritance tax. From a UK perspective, Pissarides argues for some increased taxation of housing. He is in favour of taxing the capital gains from the sales of houses, rather than (at present) only taxing housing when it is inherited. He believes this could also have a beneficial effect on house prices, which are <a href="https://theconversation.com/just-building-more-homes-wont-fix-the-housing-crisis-heres-why-60655">becoming unaffordable</a> for many young people.</p>
<h2>The paradox of global inequality</h2>
<p>While much of the meeting focused on inequality in rich countries, the question of inequality in developing countries was not ignored. Eric Maskin, the 2007 Nobel laureate <a href="https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2007/maskin-facts.html">for his work on mechanism design</a>, pointed out the paradox that while global inequality between countries was narrowing, due to the rapid economic growth of China and India, it was “deeply troubling” that inequality within developing countries was increasing. </p>
<p>Maskin suggested that this was in contradiction to the widely held economics theory of <a href="http://www.investopedia.com/terms/c/comparativeadvantage.asp">comparative advantage</a>. This is the idea, put forward by economist <a href="http://www.econlib.org/library/Enc/bios/Ricardo.html">David Ricardo</a> in the 19th century, that the wages of unskilled workers in poorer countries rise as they enter global markets. Maskin suggested that this no longer holds as we now have an integrated global labour market – not a national one – with global supply chains and communications networks enabling companies to ignore national boundaries.</p>
<p>One of the purposes of the Lindau meeting is to encourage younger economists to think radically about what new areas of research they should focus on. It may be that these discussions will inspire the next generation to develop new policies to tackle the challenge of poverty and inequality. </p>
<p>Economics has often been characterised as the “<a href="https://books.google.co.uk/books/about/Fixing_Economics.html?id=eQC3DAAAQBAJ&redir_esc=y">dismal science</a>” for its failure to engage with real-life issues or prevent crises like the 2008-09 global financial crisis. If this new approach takes hold, this could radically change.</p><img src="https://counter.theconversation.com/content/83171/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Schifferes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Inequality was the hot button issue at the triennial meeting of the world’s top economists.Steve Schifferes, Professor of Financial Journalism, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/514682015-11-30T05:05:06Z2015-11-30T05:05:06ZNobel Laureate Douglass North’s work leaves a strong legacy for economics<figure><img src="https://images.theconversation.com/files/103580/original/image-20151130-11609-t87doj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The work of Douglass North, who died last week, continues to inspire studies of economic history.</span> <span class="attribution"><span class="source">UNU-WIDER/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>Douglass C. North, who died last week at the age of 95, was one of the less well-known Nobel Laureates in economics. But his contributions to economic theory have had an enormous influence on how scholars understand institutions and the process of economic change.</p>
<p>North received the 1993 Prize alongside Robert Fogel “for having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change.” In part, the Prize recognised a career devoted to understanding “what made economies work the way they did or fail to work”. </p>
<p>North focused on economic history in the belief that we need first to develop an understanding of what determined the performance of economies through time before we can an attempt to improve their current performance.</p>
<p>North’s analysis of the economic performance of nations focused on the role of institutions. He asserted loudly that institutions matter. Indeed, he argued that institutions are the underlying determinants of economic performance; more important that other factors commonly ascribed key roles, such as changes in technology or relative prices.</p>
<p>Institutions are “the humanly devised constraints that structure human interaction”. They comprise all those elements of the social environment that regulate how we can interact with each other. Institutions include laws, rules and constitutions, as well as social norms and conventions.</p>
<p>North argued that institutions matter for economic performance because they affect transaction costs. Transaction costs include the costs involved in designing, negotiating and enforcing trade contracts; the formal and informal contracts involved in buying and selling goods and services. When institutions are missing or weak; for example, when laws are poorly specified or not enforced, the costs and risks of engaging in trade will be high and the prospects for economic expansion will be low.</p>
<p>North’s studies of economic performance featured the extensive use of historical case studies. In a seminal paper in 1968 he linked productivity gains in ocean shipping after 1600 to institutional changes, such as the regular policing of the shipping lanes to reduce piracy. These changes enabled merchant ships to reduce armaments, manpower and insurance costs and this made trade more profitable and encouraged the development of new shipping technologies. </p>
<p>In later work North applied his notions about the importance of institutions more broadly and ambitiously. For example, in collaboration with John Wallis and Barry Weingast in 2006, North attempted to use institutional theory to reinterpret the last ten thousand years of human history. They described how the formation of small groups of elites and militarised coalitions within tribes limited outsiders’ access to land, labour and capital within territorial zones, and protected valuable activities such as trade, worship and education. </p>
<p>This generated rents for elites, which, in turn, encouraged cooperation, specialisation and trade – rather than warfare - between neighbouring territories. North and his colleagues argued that this equilibrium proved both profitable and persistent, to the extent that “limited access orders” came to dominate the behaviour of these societies; that is, the stable state became the de jour “natural state”.</p>
<p>An important theme in this narrative is that institutional change is likely to come about when powerful economic or political agents perceive that they can capture additional gains. This reflects North’s close ties to the rational choice tradition, which suggests that institutions evolve in response to the needs and interests of individuals. However, North also recognised that people’s perceptions are influenced by their current cultural context and flows of information. He argued that the development of institutions and economies will be “path dependent” - constrained by the existing set of institutions and incentives – and not necessarily, or usually, optimal in terms of economic efficiency. North emphasised that time matters in the determination of economic performance, as well as institutions.</p>
<h2>Australian implications</h2>
<p>Recently we adopted Douglass North’s institutional framework to explain why Western Australia and South Australia, established in 1829 and 1836 respectively, had considerable disparities in economic growth up to 1900. By 1880, when the difference in GDP between the colonies was at its largest, SA’s economy was almost eight times the size of WA’s. We linked this disparity to the establishment of the two colonies under different theories of organisation: WA under the mercantile system of granting land to colonists based on the value of assets they owned; and SA under the Wakefieldian approach where land was sold to colonists and the capital proceeds used to pay for labour and government. The systems affected the distribution of property rights, the subsequent evolution of capital markets and other institutions across the 19th century, and ultimately their economic performance.</p>
<p>As sad as the passing of North is, his work and life should be celebrated as it continues to inspire studies of economic history. The analytical framework that North developed provides ongoing opportunities for us to understand – and learn from – our economic history.</p><img src="https://counter.theconversation.com/content/51468/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Siobhan Austen receives funding from AusAID and the Australian Research Council. </span></em></p><p class="fine-print"><em><span>Darren O'Connell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>North’s work and life should be celebrated as it continues to inspire studies of economic history.Siobhan Austen, Associate Professor, School of Economics & Finance, Curtin UniversityDarren O'Connell, Sessional Lecturer, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/490332015-10-14T05:28:59Z2015-10-14T05:28:59Z‘Correct and brilliant’: Angus Deaton’s work is a model of applied economics<p>“In physics, Nobel prizes are awarded for being correct while in economics they are often awarded for being brilliant.” So said former World Bank president Robert Zoellick. Economist Angus Deaton <a href="http://www.princeton.edu/%7Edeaton/downloads/letterfromamerican_oct2011.pdf">noted</a> the contrast and pondered how interesting it might be to classify economics laureates into Zoellick’s two boxes. Now, Deaton himself has won the Nobel prize for economic sciences. He clearly belongs in both.</p>
<p>Deaton was <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2015/advanced-economicsciences2015.pdf">cited</a> for his “three to four decades” of work on consumption. No-one can work in this field without being deeply influenced by what he has done. Wherever one turns in the analysis of consumption, Deaton has been there, has seen deeply into the issue and shaped the questions being asked. </p>
<p><div data-react-class="Tweet" data-react-props="{"tweetId":"653529238587461632"}"></div></p>
<p>To me, his work is a model of what applied economics ought to be. No award the Nobel committee has made has pleased me as much, for the recognition it gives both him and the type of work he does.</p>
<p>Deaton’s subject matter, at its broadest, is the welfare of households. Understanding how to measure living standards is the foundation of accurately assessing policy outcomes such as poverty and inequality, and understanding how living standards are determined by economic circumstances is the foundation of designing policies to address those social problems. From an economic perspective, living standards are determined by what households consume. Deaton made his name by looking both at how budgets are spent within periods and how spending is spread over periods in a lifetime by borrowing and saving.</p>
<p>Designing policy to promote welfare requires an understanding of how the goods that people consume depend on their incomes and the prices they face. The best model we have for that starts with the assumption that households make choices to best satisfy their preferences given what they can afford. Such a model not only structures interpretation of behaviour but also allows us to infer things about how prices and incomes affect their welfare. Design of taxes on goods, say, can thus be made to best serve households’ interests – a topic of early interest in his career.</p>
<p>But a specification that is too simple may neither fit the data nor leave scope for evidence to decide the policy questions we are interested in. Too complex a specification and we are left with an uninterpretable mess. Deaton, with colleague John Muellbauer, crafted a model – the <a href="https://www.aeaweb.org/aer/top20/70.3.312-326.pdf">Almost Ideal Demand System</a> – which strikes a near-ideal balance between these considerations. It has become the mainstay of applied work. Easily estimated, delivering straightforward tests of the underlying theory, but flexible enough to describe data well, the Almost Ideal model is an exemplary marriage of applied work and economic theory.</p>
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<p>Beyond this, Deaton’s contributions to demand analysis are legion, always aimed at a sophisticated bridging of the gap between the necessary simplifications of theory and the nuances of applied work. He has helped us understand, for example, how to compare economic well-being between households of different demographic types in a way that is consistent with demand behaviour; or how to incorporate a recognition of how the prices consumers pay for goods may reflect decisions on quality choice.</p>
<h2>Consumption and saving</h2>
<p>The second strand to Deaton’s work mentioned in the Nobel citation covers the allocation of spending over time. Once, this was a concern more of macroeconomics than microeconomics but Deaton, with his co-authors, has been a pioneer in treating consumption and savings behaviour empirically at the household level. This focus on the household is central to his work – assuming lessons about individuals can be learned from aggregates is <a href="https://www.princeton.edu/%7Edeaton/downloads/deaton_puzzles_and_paradoxes_v1_5_11_17_11.pdf#page=7">typically</a> “as dangerous and misleading” as it is “unrealistic”. </p>
<p>Empirical work here is problematic because households’ lives are longer than the periods over which they are observed in surveys. His work develops techniques to overcome this by combining data sources, grouping households by dates of birth and following generations across surveys so that the right questions can be addressed. </p>
<p>From that work emerges an understanding of how households learn and adapt to the arrival of information about lifetime incomes by changing their consumption plans as they age. Different sorts of shocks – sometimes temporary, sometimes permanent – can be accommodated differently and feed through differently into spending as, within each generation, cumulation of shocks drives inequality in consumption and income. </p>
<p>Finally, the application of Deaton’s work to the understanding of poverty in developing countries – especially through the use of household survey data – is credited with “immense practical significance”.</p>
<h2>Combining data and theory</h2>
<p>Many different themes run through Deaton’s work – one of which is an emphasis on the importance of measurement. In his view, data collection and economic theory have become too separated, to the advantage of neither the data collector nor the economic theorist. Collectors need the guidance of theory and analysts need to understand the data they work with. <a href="https://www.princeton.edu/%7Edeaton/downloads/deaton_puzzles_and_paradoxes_v1_5_11_17_11.pdf#page=11">Too often</a>, Deaton says: “what we think we know about the world is dependent on data that may not mean what we think they mean”.</p>
<p>There is always stress on the integration of measurement and theory, but the sort of theorising of which Deaton is a master is not idle abstraction but woven into applied analysis. In this he <a href="https://www.princeton.edu/%7Edeaton/downloads/deaton_puzzles_and_paradoxes_v1_5_11_17_11.pdf#page=4">aligns himself</a> with the views of the Irish economist <a href="http://www.theguardian.com/news/2003/jan/31/guardianobituaries.obituaries">Terence Gorman</a>: “who saw the task of theory as providing models and methods that made life easier for applied analysis”.</p>
<p>Deaton regrets the possibility that “the mould for that kind of theorist has been lost”. Through his own work, however, he shows us that such integration is still possible.</p>
<hr>
<p><em>This article was <a href="http://www.statslife.org.uk/economics-and-business/2510-angus-deaton-a-statistician-s-economist">co-published with the Royal Statistical Society</a>.</em></p><img src="https://counter.theconversation.com/content/49033/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ian Preston's work on consumption has been funded mainly by the Economic and Social Research Council and occasionally by government departments.</span></em></p>An Angus Deaton school of economics marries data collection with theory to find solutions to real-world problems.Ian Preston, Professor in the Department of Economics, UCLLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/423332015-05-26T10:06:30Z2015-05-26T10:06:30ZJohn Nash: a beautiful mind and its exquisite mathematics<p>John Nash, mathematician and <a href="http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1994/">Nobel laureate in economics</a>, died in a taxi accident on May 23; he was 86. His wife, Alicia, was with him and also did not survive the crash. The Nashes were on their way home to Princeton from Norway, where John was honored as a recipient (along with Louis Nirenberg) of this year’s <a href="http://www.abelprize.no/">Abel Prize</a> in mathematics.</p>
<p>Thanks to A Beautiful Mind, Sylvia Nasar’s chronicle of Nash’s life, and its film adaptation starring Russell Crowe, Nash was one of the few mathematicians well known outside the halls of academia. The general public may remember the story of Nash’s mental illness and eventual recovery from paranoid schizophrenia. But Nash’s influence goes far beyond the Hollywood version of his biography. His <a href="http://mobile.nytimes.com/2015/05/25/science/john-nash-a-beautiful-mind-subject-and-nobel-winner-dies-at-86.html">colleagues count his mathematical innovations</a>, particularly on noncooperative games (the work that would earn him his Nobel Prize), among the great economic ideas of the 20th century.</p>
<h2>Noncooperative games</h2>
<p>Nash is best known for his work in game theory. In mathematics, a game involves two or more “players” who earn rewards or penalties depending on the actions of all the participants. Some games are called <em>zero-sum</em>, which means that one player’s gain is another player’s loss. Nash’s work applied to <em>noncooperative games</em>. In these situations, players may unilaterally change strategy to improve (or worsen) their own outcome without affecting the other players.</p>
<p>The prototypical example of such a game is the basic Prisoner’s Dilemma. Two criminals have been captured and detained in separate cells, unable to communicate with each other. The prosecutors do not have sufficient evidence to convict them on the primary charge, but they can convict them on a lesser charge which comes with a one-year sentence. The prisoners are offered a deal: Testify against the other defendant (ie, defect) and go free while he serves three years. However, if both defendants betray each other, both will serve two years. If neither betrays the other (ie, they cooperate), then they will both be convicted of the lesser charge and serve the one year. The outcomes may be summarized in a <em>payoff matrix</em>.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=144&fit=crop&dpr=1 600w, https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=144&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=144&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=181&fit=crop&dpr=1 754w, https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=181&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/82862/original/image-20150525-32558-yqpwyc.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=181&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The payoff matrix for the Prisoner’s Dilemma. In parentheses, the sentences are ordered (Player A, Player B).</span>
<span class="attribution"><span class="source">generated by the author</span></span>
</figcaption>
</figure>
<p>What Nash discovered is that any such game has a strategy, now called a <em>Nash equilibrium</em>, where any unilateral change in strategy by a player results in a worse outcome for that player. In the case of the Prisoner’s Dilemma, there are two such equilibria, the upper-left and lower-right squares in the payoff matrix. Indeed, in the situation in the lower-right corner, if either player changes his strategy unilaterally and decides not to defect, he will increase his sentence and thereby end up with a worse outcome. This example is particularly vexing because the upper-left strategy is clearly the best way to go for the prisoners (they should remain silent), but purely rational players will end up at the lower-right position.</p>
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<iframe width="440" height="260" src="https://www.youtube.com/embed/CemLiSI5ox8?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">A Beautiful Mind famously dramatized Nash’s discovery of what’s now called the Nash equilibrium.</span></figcaption>
</figure>
<p>Game theory has applications in many fields, including economics and political science. Many scenarios in international relations may be modeled as noncooperative games. For example, the development of nuclear programs during World War II can be modeled as a sort of Prisoner’s Dilemma, in which the two sides each decide to pursue a bomb for fear the other side will do so. This, of course, led to the less-desirable outcome of nuclear proliferation, analogous to both prisoners defecting.</p>
<h2>Embedding theorems</h2>
<p>While Nash is best known globally for his work on game theory, most mathematicians think of his results on embeddings of Riemannian manifolds as his most innovative and important. In this subspecialty of geometry, an <em>n-manifold</em> is a space which locally looks like <em>n</em>-dimensional Euclidean space (the typical three spatial dimensions we’re used to form a 3-dimensional Euclidean space). For example, a surface, such as a sphere or hollow donut, is a 2-manifold since any point on the surface has a small disc around it; to a small bug standing at the point, the surface looks like a flat 2-dimensional plane (hence the ancient belief that the Earth is flat).</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=186&fit=crop&dpr=1 600w, https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=186&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=186&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=234&fit=crop&dpr=1 754w, https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=234&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/82863/original/image-20150525-32551-19u3u9h.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=234&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Given two vectors in Euclidean space, the angle (theta) between them may be defined via the formulas on the right.</span>
<span class="attribution"><span class="source">generated by the author</span></span>
</figcaption>
</figure>
<p>A manifold is <em>Riemannian</em> if there is a globally consistent way to define angles between vectors tangent to the manifold at a point. In particular, this allows us to define distances between points on the manifold and to find the lengths of curves embedded in the manifold. Euclidean space with its usual notion of angle and distance is the simplest example.</p>
<p>Now imagine trying to put an abstract Riemannian manifold inside Euclidean space. You might twist it up and do all sorts of strange things that end up distorting the angles between tangent vectors on your manifold. The Nash-Kuiper Embedding Theorem asserts that we can always fix this problem; that is, we can find a realization of a Riemannian manifold of dimension <em>n</em> into a Euclidean space of dimension <em>n+1</em> such that the angles are preserved. Then you can compute distances between points on the manifold more easily using the Riemannian structure inherited from Euclidean space.</p>
<p>This may not sound earth-shattering, but the problem had vexed mathematicians for more than a century. That the dimension of the Euclidean space cannot be made smaller than <em>n+1</em> is familiar to anyone who has studied a map – the surface of a sphere cannot be flattened onto a plane without distorting angles.</p>
<p>There are many counterintuitive implications of Nash’s theorem. For example, it implies that any closed surface may be realized inside an arbitrarily small ball in 3-dimensional space. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=426&fit=crop&dpr=1 600w, https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=426&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=426&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=535&fit=crop&dpr=1 754w, https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=535&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/82861/original/image-20150525-32575-5qxcow.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=535&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The board in Hex; blue wins.</span>
<span class="attribution"><span class="source">http://upload.wikimedia.org/wikipedia/commons/3/38/Hex-board-11x11-%282%29.jpg</span></span>
</figcaption>
</figure>
<h2>An actual game</h2>
<p>Nash is also credited with inventing a game, eventually marketed by Parker Brothers as a board game called <em>Hex</em>. This game, played on a parallelogram-shaped field of hexagonal cells, was discovered independently in Denmark around the same time. In Princeton it was called <em>Nash</em>, after its creator, or <em>John</em>, a double entendre involving the fact that it was played on the tiles in the mathematics department’s men’s room floor. There are two players, each of whom has tokens of a single color (red and blue, say). The object is to form an unbroken path from one side of the board to the other before one’s opponent does the same in the opposite direction.</p>
<p>There are <a href="http://www.lutanho.net/play/hex.html">online versions</a> of the game. The first player always has a winning strategy; that is, the player who makes the first move can always win, provided he executes the proper sequence of moves.</p>
<h2>A life’s work remembered</h2>
<p>In any given century there are a handful of mathematicians who stand out, whose work is so original and groundbreaking that it becomes a part of the language. As journalist Erica Klarreich <a href="http://www.pnas.org/site/classics/classics5.xhtml">pointed out</a>, no one cites Nash’s papers any longer because “Nash equilibrium” is standard vocabulary; every mathematician knows what it means. While he published only a small handful of papers, John Nash will be remembered as one of the most original and influential mathematicians of the 20th century, whose work continues to inspire new results and research directions.</p><img src="https://counter.theconversation.com/content/42333/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Knudson does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Nobel Prize winning mathematician made lasting contributions in the fields of game theory and topology. Famously portrayed by Russell Crowe in the movie A Beautiful Mind, he died May 23 at age 86.Kevin Knudson, Professor of Mathematics, University of FloridaLicensed as Creative Commons – attribution, no derivatives.